Commodities & Technologies for Efficiency

We've seen some significant shifts in the economy, and an increasing need to balance food and energy security, with broad sustainability and resiliency principles. It’s been exciting to see local enthusiasm for social impact, community engagement, and open innovation. Here is a short summary of the primary trends we're seeing, and how we're responding:

Economic Shift

• War in Ukraine. The human suffering has meant an estimated 3 million refugees, 977 killed, and 1,594 injured, as a result of the Russian invasion of Ukraine. Russia is now the most sanctioned country (with over 5,500 sanctions) and facing international “Economic Blitzkrieg” including: Russia’s exclusion from the SWIFT system for international inter-bank payments, the Russian Central Bank has been blockaded (WSJ) and had their assets frozen (NBC), Commercial banks in Russia have had their assets frozen, the U.S. has banned Russian oil and natural gas, Nord Stream 2 has been put on hold, myriad Western firms have ceased operations in Russia, and the Ruble has tumbled 22% (BBC and Reuters). We expect persistent increases in commodities prices.
• Interest Rates Rising. Consumer Price Index (CPI) has grown at an annualized rate of 7.8%, a 40 year high (Bureau of Economic Analysis and CNBC). COVID supply chain issues, and cost-push inflation, have been worsening on war-related price increases for food and energy. To address the price increases, and with U3 unemployment down to 3.8% (Bureau of Labor Statistics), the Federal Reserve has announced seven 0.05% rate increases. This would boost the benchmark rate to 2.8% in 2023, and the Fed is set to continue the reduction of its $9tn balance sheet (Fed, CNBC, Marketplace.org).
• Economic Growth Downgraded. Inflation, tightening monetary policy, supply chain concerns and COVID variants have led to downgrades in the 2022 forecasts of global GDP. Fitch has downgraded their prediction 0.7pp, to 3.5%. The S&P Market Intelligence GDP forecast has also been downgraded - now it's 3.3%, a significant deceleration from the 5.8% growth rate we saw in 2021 (IHS Markit). U.S. GDP grew at an annualized rate of 7% in the fourth quarter of 2021, and now there are mixed reviews on revisions to the 2022 projections, with several scenarios under consideration (Bureau of Economic Analysis and Deloitte).

Capital Markets

• Commodities. Materials, energy and food constraints are expected to persist. As mentioned last month, supply-side expectations are hitting commodities markets, with the S&P GSCI Total Return Index up 63% over the past year (Bloomberg). Particularly, Russia-based constraints loom for the following commodities: liquified natural gas (LNG), refined petroleum, coal briquettes, iron ore, raw aluminum, lumber, and wheat (OEC). Predictions of food shortages are based on disruptions to spring planting in Ukraine, and broader concerns on the availability of fertilizers made with nitrogen, phosphorus, and potassium.
• Flattening Yield Curve. The spread between 2-year and 10-year treasury yields “shrank to 13 basis points…down from a high as 130 basis points last October” (Marketwatch) This is a strong indicator of recession, and leaving us a monetary policy tightrope to bring prices under control, while avoiding stagnation. “Bond prices are sliding” and investors are seeing some their “worst losses in years” (Morningstar). This is likely to be exacerbated by the Fed’s efforts in mortgage-backed securities (MBS), which will drive prices lower and yields higher (Financial Times).
• Public Equities. Higher rates mean higher financing costs, which most impacts capital intensive industries and firms funding their balance sheets with debt. Commodity price increases translate into higher energy and materials costs for producers, with service providers less impacted. Banks will have poorer returns as their interest rate spread is compressed (Marketwatch), The industries (outside Russia) who are benefiting, include: extractive firms (think oil, LNG, mining & metals), agribusiness (wheat, barley), and defense. The losers: airlines, grocers, auto manufactures, and electric vehicles, too (Economist).

Small Business Responses

• Pricing. As inflation continues, we (and our clients) are consistently examining prices relative to competition and ensuring sufficient margin. As we raise prices, we risk losing sales; but keep them too low and we’re leaving money on the table. The theoretical optimal price is one where marginal revenue equals marginal cost, but the difficulty lies in estimating demand elasticities (i.e. the amount of sales lost as prices increase). Firms like PriceFx are gathering data to generate better estimates.
• Capital Availability. We’re seeing increases in the cost of capital, and can expect more in the future. From lines of credit to term loans, and from home equity to credit cards, we can expect lenders to increase rates as they maintain their spread, or the difference between the rates they pay and the rates they charge. ?These cost increases will mean a re-evaluation of one’s cash flow from financing activities, weighted-average cost of capital (WACC), and break-even point. Consider scenario and sensitivity analyses to understand the impacts of raising prices, changes in the cost of debt, and resultant impacts on earnings.
• Securing Supply. The increased prices in commodities are rippling through supply chains, and industries more reliant on food, energy, and metals are seeing cost increases in parts and materials. These variable cost increases for inputs, also risk margin compression. At the extreme, owners will work with suppliers (hedging) to contract for future supply in anticipation of shortages.
• New Opportunity Spaces. Demographic aging in most countries is catalyzing a shift to an efficiency-based model, as opposed to our current consumption led system. Supply constraints will speed this change. This has created new opportunities in the application of technology to reduce commodity utilization for a given output, whether kilowatt-hour, caloric output cultivated, or mile-travelled. Think core human needs like food, water, housing, and then the technologies that are creating efficient scale: additive manufacturing, printing food, hydrogen technology, water purification and wastewater, optical software to optimize fertilizer application, per plant, and maximize crop yield. ??

Our Work Democratizing Ownership

• Through our nonprofit, we’ve assisted hundreds of small business owners, as they plan, launch and grow successful ventures. Our mission is to eliminate structural barriers to business ownership, and to expand opportunities for good livelihoods.
• Research. We’re currently engaged in related research to expand social impact though small business development (with the Small Business Administration), machine learning to extend more debt capital for lower income populations (with the University of Liverpool), and measuring disparities in local ecosystems for entrepreneur support services (with Kauffman and Virginia Commonwealth University).
• Programs. We operate a related accelerator, serve as a community sponsor of 1 Million Cups Richmond (peer learning and connections for founders), and we're developing the Open Trellis software – the place small businesses go to grow (www.opentrellis.org).
• Haiti. We’ve been expanding economic opportunity on the central plateau of Haiti, through our creation of a community-based microlending program, with St. Paul’s of Carissade and Caritas Internationalis. A decades long missionary and humanitarian outreach of the Catholic Church has included education and healthcare initiatives. Now our microfinance program, over three years, has seen 100% of the loans repaid and no one has defaulted.
• Volunteering & Fundraising. Our national sponsors and partners are vital to our work, but we're especially grateful to our 37 volunteers, who serve as community organizers, program directors, board officers, guest speakers, mentors, software developers, product designers, and marketing specialists. Their contributions help us democratize ownership, and use the tools of economics and business to build businesses, ameliorate generational wealth gaps, create jobs and increase incomes.?

Please feel free to contact me about this work – teaching entrepreneurship, researching economic trends, advising our clients, and making a difference.

--Dale